Fixed IncomeMay 21 2013

Investors warned of bond sell-off

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BNY Mellon’s bond managers have urged investors to prepare for a possible unwinding of quantitative easing (QE) in the US as the country’s government bond yields have begun to rise.

The yield on 10-year US treasury bonds – which moves inversely to the price – rose 21 per cent in two weeks at the start of May amid improving economic data from the US.

Fixed income managers at BNY Mellon’s subsidiary companies Newton Investment Management and Insight Investment have both warned that investors should begin preparing for the consequences of an end to QE.

Speaking at BNY Mellon’s annual fixed income conference in Paris, Paul Brain, head of fixed income at Newton, said investors needed to “prepare for battle” in the next 12 months before interest rates were expected to start to increase.

Insight’s head of UK and global credit Peter Bentley added: “Beyond six to 12 months there is a massive risk of a return to normality and potentially big losses in normal bond funds.”

He added: “There is an overhang of bonds to be sold by central banks. If yields go back to where they were in 2008, traditional bond funds could lose 5-10 per cent.”

Mr Brain, manager of the £805m Newton Global Dynamic Bond fund, said although the exact timing of the end of QE was unknown, “given where interest rates are it does not cost very much to be ready” for a sell-off in government bonds.

But he added: “You need to think how much is priced in before positioning funds. There is already a sell-off priced into parts of the yield curve.”

But David Leduc, chief investment officer at Standish Investment Management, another BNY Mellon subsidiary, argued there was a potential cost to investors if they moved to defend against bond price falls too early.

“I know of an equity company which positioned for the end of the technology bubble three years too early and lost half of its assets,” Mr Leduc said.

“Investors need to think carefully about when and how to prepare for a sell-off.”

Mr Bentley has a “small” short position in US government bonds in his €141.9m (£119.9m) BNY Mellon Absolute Return Bond fund, to cash in on falling prices.

The manager said that “over time” the fund could increase its short books and even become “net short”, which would imply a major negative bet on bond markets.

Mr Brain in contrast has a long position in US government bonds, but said this holding – as well as others in bonds with negative real yields after factoring in inflation – was largely due to “the potential for disasters elsewhere”.